Weak economy, lack of competition drive Fannie Mae to adjust underwriting in first half.

Fannie Mae is processing deals hand over fist this year even as it makes significant adjustments to its credit standards.

In early April, Fannie Mae moved to a standard 1.25x debt-service coverage ratio (DSCR) and down to 1.20x in strong markets such as New York, Los Angeles, and Seattle.

Last year, Fannie Mae had lowered that threshold to a standard 1.20x and down to 1.15x in strong markets. The move was a reaction to the aggressive underwriting by conduit lenders who were stealing much of the market share from Fannie Mae.

“Fannie Mae frankly was never really comfortable with the 1.20x debtservice cover,” said Byron Steenerson, president of Alliant Capital, LLC, a Delegated Underwriting and Servicing (DUS) lender. “But there was a fairly strong competitive pressure to be down there because of the conduits.”

The change back to the historical norm of 1.25x DSCR is a reflection of the reduced competitive environment, as conduit lenders continue to wait on the sidelines. “It’s also partly a reflection of concern for the overall economy,” said Don King, senior vice president and national agency director for DUS lender CWCapital. “There’s a lot more concern today on the short- and medium-term economic outlook.”

In addition, Fannie Mae has tightened its underwriting standards on short-term loans. Last year, five-year deals could be sized up to an 80 percent loan-to-value (LTV) ratio, but Fannie Mae changed the LTV ratio on five-year deals to 75 percent in the first half of 2008.

Fannie Mae has also made some borrower- friendly changes to its criteria for underwriting acquisition deals.

In the past, lenders used a rigid, formulaic approach to sizing loans on acquisition deals. Lenders would look only at a property’s historical data—the trailing three months of net rental income and the trailing year of expenses —and develop a “baseline” net operating income from which to size the loan.

But with that formula lenders couldn’t take into account the potential buyer’s projections of income and expenses, which limited the amount Fannie Mae was willing to lend. Lenders would need to seek waivers from Fannie Mae to increase the loan size, a process that increased deal cycle time significantly.

“Most acquisitions are driven by a buyer’s perception that they can do a better job than the current owner,” said Steenerson. “The formula they had to look back on income was very limiting, and we weren’t able get the dollars the buyer was seeking without spending a great deal of time justifying to Fannie Mae why they should allow flexibility.”

The new formula, which went into effect this spring, allows lenders to take the buyer’s projections into account when sizing the loan, which reduces deal cycle time and ultimately increases the loan amount.

Winning deals

Both Fannie Mae and Freddie Mac are providing liquidity in a down market, and unlike other capital sources, were making deals of up to 80 percent LTV in the first half of 2008. But with so much business coming their way, the government-sponsored enterprises now have the luxury of cherry-picking which transactions they will finance.

In late April, 10-year conventional Fannie Mae deals were being priced at 225 basis points over the 10-year Treasury note, which carried a 3.81 percent yield, making the all-in rate 6.06 percent. Thanks to relatively low prices and high leverage levels, Fannie Maeaffiliated lenders are still seeing much interest in the programs, though the composition of the business has changed.

DUS lender Green Park Financial had processed about $650 million in Fannie Mae deals by late April and hopes to close more than $2 billion for the year, up from $1.2 billion in 2007. The company added eight employees in the last six months to help process all of the business that has come its way.

Green Park is getting far fewer requests for acquisition financing: Only about 25 percent of Green Park’s Fannie Mae deals are for acquisitions, down from about 75 percent in the spring of 2007.

“There’s still a disconnect between sellers’ expectations for the value of their assets and the borrowers,’” said Ted Patch, senior vice president and chief production officer for DUS lender Green Park Financial. “Now that the loan-sizing parameters are more prudent, the borrower can only borrow so much money, and that translates into what they’d be willing to pay for the property.”

But with interest rates at favorable levels, the company has seen a lot of interest in refinancing opportunities, and has also processed more manufactured housing and seniors housing deals.

Similarly, Alliant Capital said about 25 percent of its deals this year are for acquisitions, down from 50 percent normally. But the company had processed about $200 million in Fannie Mae loans by late April, with a target to produce more than $600 million in 2008, almost doubling its 2007 volume of $315 million.

Fannie Mae is working on some portfolio retention products to make the refinancing of existing Fannie Mae loans more attractive. While the company was mum on details, lenders said the time was perfect for Fannie Mae to further prove its case.

“Fannie Mae has a unique opportunity to cement their relationship with a large group of borrowers right now— both those that have come back to them [from the commercial mortgagebacked securities (CMBS) market] and those that have not used them until now,” said Steenerson. “If they can demonstrate that the system is userfriendly and competitive and that they’ll stay in the market in good times and bad, then they can really expand their market.”

CWCapital’s King believes that Fannie Mae’s outlook for the rest of 2008 is bright, as the company’s products continue to attract interest and other sources of liquidity wait on the sidelines. But even if the CMBS market comes back in 2008, it won’t come back all at once. “There will be some period of time while the conduits ramp up and prove themselves out again before they’re really going to be in a position to compete with Freddie and Fannie,” King said.